What’s Wrong with NAFTA?

The North American Free Trade Agreement (known as TLCAN in Mexico) went into effect between the U.S., Canada, and Mexico in 1994. The objectives were noble and included “STRENGTHEN the special bonds of friendship and cooperation among their nations; CONTRIBUTE to the harmonious development and expansion of world trade and provide a catalyst to broader international cooperation; CREATE an expanded and secure market for the goods and services produced in their territories; ENHANCE the competitiveness of their firms in global markets; FOSTER creativity and innovation, and promote trade in goods and services that are the subject of intellectual property rights; CREATE new employment opportunities and improve working conditions and living standards in their respective territories; UNDERTAKE each of the preceding in a manner consistent with environmental protection and conservation.”

Who could possibly object to such glorious goals? Certainly not we – until we discovered the devil in the details. We began the process of officially importing our Toyota Highlander, which had lived legally in Mexico for five years as a temporary resident vehicle, and was required to change status with us to permanent residency. We submitted the paperwork, including the VIN number, and were surprised to learn that many of the components in our car were Japanese-made and therefore, given NAFTA restrictions, not only wasn’t the Toyota eligible for a Mexican license without paying an exorbitantly high tariff, but we had a limited amount of time to drive the old buggy out of Mexico. Needless to say, we were no longer enchanted with NAFTA.

The Agreement was controversial before adoption and still is, almost 24 years later. In 1992, Presidential candidate Ross Perot, who opposed the adoption of NAFTA, memorably said “there will be a giant sucking sound going south,” referring to US jobs moving to Mexico. This kind of objection has haunted NAFTA despite repeated evaluations year after year that show fears of large job losses from US to Mexico did not materialize.

TLCAN has not been universally popular in Mexico, either. The treaty was intended to increase the number of jobs overall and reduce disparities in income and wages among the participating countries, but these desired outcomes did not occur. In 2006, presidential candidate López Obrador favored abandoning TLCAN, and he lost the election by less than 1%. Once again, hopeful of winning the Mexican presidency in 2018, López Obrador has called for suspending any negotiations until after the election. Now the US President Donald Trump complains about the US’s negative trade balance with Mexico and, over Obrador’s objections, has initiated a renegotiation of the treaty.

Just what is a negative trade balance? It means US citizens and businesses are buying more from Mexico than Mexican businesses and citizens are buying from the US. Does that sound like a bad thing to you? You may have noticed there are almost 325 million people residing in the US compared to under 130 million in Mexico, and the average household income is much higher in the US, so of course those from the US buy more goods and services than Mexicans do.

We are all familiar with the large number of tourists from the US and Canada in Mexico, compared to a small number of Mexican tourists in the US and Canada. (Tourism is an important category of trade.) But NAFTA didn’t cause this pattern. Ironically, the only directly related policy changes under discussion that could change the balance of tourism – tightening visa restrictions for Mexicans who want to enter the US, or deporting Mexican visitors – would reduce the number of Mexicans who travel, work, or study in the US and thereby worsen the trade deficit with respect to tourism.

The important change that happened under NAFTA was an enormous increase in the amount of trade between Mexico and the US. The trade deficit merely reflects that US companies and consumers find products and services in Mexico that they want to buy. One reason for this is that under NAFTA a unique form of production sharing has developed between the US and Mexico – to a much greater degree than with any other country. US companies export intermediate inputs to Mexican manufacturing companies, which then assemble the finished product and export it back to the US. As a result, now over 40% of the content of goods imported into the US from Mexico is of U.S. origin. This form of cooperation has helped make US businesses more globally competitive.

A March 31, 2017, article in the New York Times highlighted how Tijuana has become a major manufacturing area for medical devices used in the US. It says, “This city houses the highest concentration of Mexico’s medical device firms, 70 percent of which are American owned…. Giant banners hanging from manufacturing plants plead for workers to join them.” US hospitals depend on Mexican engineers and skilled technicians to make orthopedic devices, surgical equipment, and catheters out of raw materials that are up to 90% sourced in the US. This is only one example of production sharing – all told, 6 million American jobs (inside the US) depend on trade with Mexico.

Nonetheless, there are many good reasons for renegotiating NAFTA. As Mexican Supreme Court justice Eduardo Medina Mora said, at a time when he was ambassador to the US, “Our nations are currently engaged in twenty-first-century trade that relies on twentieth-century regulations and nineteenth-century infrastructure.” NAFTA is in essence a complex system of tariffs for particular commodities or businesses, such as textiles or agriculture or communications, together with detailed rules about how the tariffs can be reduced to zero, primarily by ensuring that more than a specified percentage of each product has its source in North America. The numerical values of these tariffs and percentages differ so substantially between Mexico and Canada that in practice NAFTA operates like two bilateral treaties, one between the US and Canada and the other between the US and Mexico.

The major problem identified by Mora is that the goods and services included in the NAFTA agreement were a comprehensive list in 1994 but now poorly match some major categories of trade. Further, the complex rules for determining tariffs are an antiquated method for regulating trade and lead to extensive paperwork, confusion, and errors, not to mention opening opportunities for corruption.

As we and many other Americans and Canadians found when faced with the NAFTA regulations for motor vehicles or other products, they involve almost incomprehensible calculations of “rules of origin” which specify where and what percentage of a product, such as a car or truck, was manufactured; a car or truck must be 62.5% from a North American source to avoid import duties.

NAFTA could be changed to build a stronger world market for goods made in North America. Mexico’s government has entered the NAFTA negotiations with the hope of refocusing on the goal of strengthening North American competitiveness in the world economy. Goals of Mexico’s government include adding or revising provisions that are responsive to the needs of a 21st century economy, and promoting investment in North America by individuals and businesses in other countries.

Mexico also opened up a one-month comment period when individuals or businesses could express their hopes or fears for the negotiations. In all, 613 comments were received from businesses, academics, and ordinary citizens. Major topics covered were equal access to markets, simplifying the administration of customs and the rules of origin, adapting to electronic commerce, and streamlining trans-border transportation. A small but interesting group of comments reflected a desire for the US to retain its TN visa program. This form of visa allows Mexican and Canadian citizens to live in the US, along with their families, while working for a company that has trans-national operations subject to NAFTA regulations; it was considered vital for the smooth operation of NAFTA.

With such divergent goals on the US and Mexico sides of these negotiations, it is possible to envision a negative outcome, a positive outcome, or complete collapse of the negotiations altogether. To date, the tripartite announcements on the conclusion of each round of negotiations have emphasized that great progress is taking place. But perhaps only the easy issues on which all parties agree have been tackled so far. Anything can happen, but if you are currently thinking of importing a car with parts made by a company based outside North America, don’t count on it being tariff-free.